Skill, Luck, and the Multiproduct Firm: Evidence from Hedge Funds
Coauthor(s): Rui de Figueiredo, Jr..
Adobe Acrobat PDF
We formalize the idea that when managers require external investment to expand, higher-skilled firms will
be more likely to diversify in equilibrium, even though managers can exploit asymmetric information
about their ability to raise capital from investors. We exploit the timing of new fund launches in the hedge
fund industry to distinguish between agency and capability effects in firm product diversification decisions,
using a large survivor-bias-free panel data set on the hedge fund industry from 1994 to 2006. Empirically we
show that diversifying firms' excess returns are high relative to those of other firms prior to diversification and
fall within firm following diversification, but are six basis points higher per month per unit of risk ex post
compared to a matched sample of focused firms. The evidence suggests that managers exploit asymmetric
information about their own ability to time diversification decisions; yet, the discipline of markets ensures that
better firms diversify, on average. The results provide large-sample empirical evidence that agency effects and
firm capabilities jointly influence diversification decisions.
Source: Management Science
de Figueiredo, Jr., Rui, and Evan Rawley. "Skill, Luck, and the Multiproduct Firm: Evidence from Hedge Funds." Management Science 57, no. 11 (November 2011): 1963-1978.